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Outlook 2022

ETHENEA | Outlook 2022

Macro Picture

After the ‘Annus Horribilis’ of 2020, which rocked the global economy, 2021 has been the year of the ‘Great Recovery’. This year was characterised by the global economy rebounding strongly, supported by unprecedented policy stimulus and the progressive roll-out of effective Covid-19 vaccines.

During the first half of the year, both the reopening and strong policy support propelled the global economy to a powerful rebound. However, the robust economic recovery remained uneven across countries and sectors, reflecting significant differences in access to vaccines, pandemic-induced disruptions, and policy support. In the second half of the year, we saw a moderation of the solid economic growth, in the wake of a resurgence of the pandemic and as a result of soaring energy prices, input shortages, global supply chain bottlenecks, and rising inflation.

The ‘Great Recovery’ has been particularly rapid and highly unusual. It has been buoyed by a surge in aggregate demand powered by the extraordinary policy support engineered by fiscal and monetary authorities. However, the recovery in aggregate demand could not be met by an impaired supply and the resulting mismatch between demand and supply caused a sharp increase in inflation. Growth forecasts for 2021 have been revised downwards – albeit only slightly, and the global economy is expected to expand this year at a robust rate of 5.9%.

Cyclical growth will continue in 2022, although at a more moderate pace as the global economy has now entered its mid-cycle. The baseline scenario for 2022 is one of a continuous expansion of global output at a solid, above-trend pace of about 5%. This will be supported by strong domestic demand, a recalibration of growth towards the service sector, and a continued upswing in global trade once supply chain issues have been resolved. Capital investment and an increase in inventories will also contribute to solid growth next year. Although the labour market will improve progressively, it is likely to lag behind output recovery and will remain uneven across regions. In 2022, output gaps will progressively close and global output should return to pre-pandemic levels. We should also see a moderation in inflation, which should trend towards the central bank targets of 2%.

Monetary and fiscal stimuli will remain key factors for economic performance. Differences in policy support across countries and regions will continue to result in differences in recovery speed. While several emerging countries have already started reining in their policy support, governments in advanced economies will continue providing sizable fiscal support. Central banks will progressively look at normalising their policies but will be careful about withdrawing monetary support to avoid disrupting the recovery and causing a return to the mediocre pre-pandemic growth outlook. The Federal Reserve has started reducing its quantitative easing programme, however it will be patient in terms of increasing its policy rates. The European Central Bank is currently assessing options to continue its asset purchases after the expiration of its Pandemic Emergency Purchase Programme (PEPP) and the Bank of Japan is likely to continue its very expansionary policies. Other central banks in advanced economies (e.g., the Bank of England and the Bank of Canada) are likely to tighten their policies earlier next year - but with the expected moderation in growth and inflation, interest rates will only increase at a modest pace. Therefore, global financial conditions are likely to remain broadly accommodative in 2022.

While the baseline scenario is encouraging, the global economy will face several headwinds and uncertainty will remain high. Persistent input shortages, supply chain bottlenecks, and soaring energy prices could lead to prolonged inflationary pressures and entrenched inflation, forcing central banks to tighten their policies earlier than expected. The aforementioned mismatch between demand and supply represents the highest downside risk for growth and the most relevant upside risk for inflation. The combination of slowing economic momentum and stubbornly high inflation is both concerning for the macroeconomic outlook and challenging for policymakers. Inflation is likely to remain elevated during the first half of 2022, however, in most countries it should progressively revert to its pre-pandemic range once the pandemic disturbances are absorbed and the prices re-adjust accordingly to a lower level. Economic growth should remain solid. Central banks in the advanced economies will have to walk a fine line between continuing to support the economic recovery while avoiding losing control of inflation.

The macroeconomic and geopolitical developments in China and the future of the US-China relationship will also impact the global economy in 2022. More generally, next year will provide further insights into the course of globalisation. The decisions of political leaders around the globe on whether to decisively return to the path of collaboration and multilateralism or to opt for protectionism and unilateralism will shape economic cooperation, international trade, and global growth in the coming years. Finally, the Covid-19 pandemic is not yet completely under control and the development of new contagious variants still poses a significant risk that threatens the resilience of the economic recovery. If inflationary pressures can be successfully alleviated and the Covid-19 pandemic progressively brought under control at a global level, the relatively benign scenario of above-trend global growth could continue in 2022.


Solid outlook for bonds, despite the likelihood of less central bank support

In 2021, the central banks continued to buy bonds in record volumes, which provided strong support for the bond markets. Yield increases have been comparatively moderate despite a rapidly recovering economy and, in some cases, a marked overshooting of inflation rates.

In 2022, we expect central banks to gradually move away from their ultra-accommodative monetary policy and to continue tapering their liquidity expansion, which in some cases has already begun. The ECB has already scaled back its bond purchases, from around EUR 80 billion in the second and third quarters to EUR 65 - 70 billion in the fourth quarter. In March of next year, the Pandemic Emergency Purchase Programme (PEPP) will expire. While we consider an extension of the programme unlikely, given the very favourable financing conditions and low corporate insolvencies, a gradual transition to the regular Asset Purchase Programme (APP) is certainly possible. This would mean that the stimulus would continue, albeit on a much smaller scale. In the US, the monetary policy stance is much clearer. In November and December, the Fed will reduce its USD 120 billion bond-buying programme by USD 15 billion per month and will probably have completely scaled down the programme by the middle of next year. The next step could then be the first interest rate hike.

Given the tailwinds provided by the central banks, we expect the economy will continue to recover and will experience another upswing. Early indications are that the situation related to supply chain bottlenecks and high transport and energy prices is gradually easing, which would reduce inflationary pressures in the coming year. In other areas, the situation remains strained, particularly in the labour market, where there still appears to be significant upward pressure on wages. A moderate wage-price spiral would definitely be a negative scenario for global bond markets and would force central banks to raise interest rates early. However, that is not the current scenario.

Our base scenario envisages a further moderate rise in yields in the coming year. In 2021, yields in the US dollar area rose considerably more than those in the eurozone, which is why we see some catch-up potential in light of the expiry of the PEPP programme. On the other hand, high demand from institutional investors such as insurance companies, pension funds, banks and hedge funds, which require sovereign bonds as collateral for their leveraged strategies, will limit the potential for significantly higher yields.

On the corporate side, we expect earnings to remain stable in the coming year, although higher production costs may put pressure on some companies that have less pricing power. We therefore continue to favour companies with robust business models and solid margins that are better able to pass on higher input costs to customers due to their market position. Spreads on investment-grade corporate bonds are likely to remain low, as companies have sufficient liquidity for years to come and tend to use the primary market very opportunistically, for example in the case of favourable financing conditions or for mergers and acquisitions. In the high-yield market, spreads may widen to a limited extent, due to the extremely low level of stress in the market.
Therefore, overall, we expect a solid ‘carry’ year on the bond side with low volatility and ongoing coupon payments, but also no significant price increases due to the already very low spreads and the limited potential for further spread tightening.


Higher volatility in all asset classes expected

After a year of impressive returns in equities, for 2022, the question of whether, in a flexible multi-asset portfolio, it still makes sense to be strongly overweight in an asset class that is also historically highly valued is a legitimate one. For us, the answer is a resounding ‘yes’. However, compared with a year ago, we are seeing a little less of the proverbial euphoria. Of course, the argument that there is no alternative is still a valid one. However, as long as real yields are negative, growth rates turn out to be as positive as expected, and inflation settles at an elevated but moderate level, we are convinced that we will still be investing in a type of ‘goldilocks’ scenario. The expected global earnings growth of 8 -10% will lead to roughly comparable growth rates for the corresponding indices at more or less unchanged valuation levels. Of course, these forecasts are subject to a great deal of uncertainty in light of the impact of the global pandemic. However, in this context, the progress of the vaccination campaigns is less important to us than the developments we are currently seeing in terms of the supply bottlenecks. As a change in the supply situation creates an opposite effect on growth and inflation, an improvement or deterioration in this area has significant implications for future scenarios. We expect a quicker resolution of these problems than is currently anticipated. Finally, even in the face of a pandemic-related global recession, typical cycle-based investment patterns still both apply and work, however, they have been accelerated significantly, due to the massive fiscal and monetary support measures of the past 18 months. While the economic cycle is still very young, the conditions we are seeing argue more in favour of the middle of a cycle, and valuations are already comparable to an end-cycle phase. Based not only on this logic, but also on the simple fact that historically low spreads provide very little return given the very likely risk of rising interest rates, objectively viewed, bond markets remain a rather unattractive source of return. Nevertheless, in a multi-asset context, we consider an - albeit small - base stock of fixed income securities to be indispensable as a stabiliser during potential periods of stress. Our US dollar allocation offers a similar stabilising function, but with an additional fundamental tailwind. In addition to diverging central bank policies, which result in a widening of the interest rate differential that is positive for the greenback, it is primarily the global growth slowdown that favours a stronger US dollar. The US dollar tends to strengthen when global trade slows down. After several quarters of very high growth rates, due to pandemic-related catch-up and normalisation effects, we expect a gradual slowdown, which in turn should lead to a stronger US dollar. For gold, this expectation is more likely to have a negative impact. Because we also expect a rise in real interest rates, we remain sceptical about the precious metal for 2022 - as long as there is no significant catalyst - and have no gold exposure in the portfolio.

However, it is worth noting that compared to the past year, we expect significantly higher volatility with lower returns in all of the asset classes discussed, due to the aforementioned uncertainties. In light of this, we are continuing to rely on both the element of diversification and our overlay systems in the management of the Ethna-AKTIV. This ensures that the extremely likely fluctuations, and also declines in value, are minimised and ultimately that we achieve an attractive risk-adjusted return.


Equities will continue to be favourites in 2022

Seldom has a glance at the past been more helpful than for the current outlook for the equity markets in 2022. As we wrote in our outlook about a year ago: “Sometimes the way forward seems to be clearly mapped out. For example, when it comes to the equity market outlook for 2021. The list of supporting factors is long and impressive.” In fact, this list of supporting factors was so long and so strong that, after the unprecedented slump in 2020, it carried equity markets through all of the past year with substantial tailwinds. Will this now end on December 31 2021? A resounding ‘no’. Is the tailwind still as strong as it was at the beginning of 2021? Another resounding ‘no’. For the most part, the proverbial ‘low hanging fruit’ have already been harvested. Across the market, equity investors will have to make do with fewer opportunities. A repeat of the recent above-average returns is barely conceivable at index level. Nevertheless, the prospects for a continuation of the current bull market - albeit at a more moderate level - are not bad. Global economic growth should again be above average in 2022. The central banks in the US, Europe, and Japan continue to assert that the recent rise in inflation figures is of a transitory nature and that, therefore, an end to the ultra-accommodative monetary policy can proceed with extreme caution. At the same time, the unchanged low return expectations for fixed income investments should mean that equities will continue to experience structurally increased demand in 2022 and that the current high valuation levels will prevail for the time being. These are the most important price drivers of the recent past and, coupled with solid sales and earnings growth on the corporate side, argue in favour of the equity markets in 2022 as well.

However, as these supporting factors continue to weaken, uncertainty and nervousness among market participants will continue to increase. This is likely to lead to rapid and sharp sector or style rotations. Whether there will be more enduring sector winners is likely to depend heavily on the inflation trend, which is one of the most significant unknowns for the new year. The inflation risks were systematically underestimated in 2021, not only by companies but also central banks and investors. If we do not see a significant improvement in this, the end-of year performance will be quite clearly sorted into inflation winners and losers. We currently see no reason to actively position the portfolio for inflation that rises above expectations. However, for risk minimisation reasons, it is certainly appropriate to avoid stocks with a lack of pricing power, which in turn would suffer disproportionately from rising inflation. Rather than individual sectors, individual investment ideas that have a convincing combination of attractive valuations and fundamental growth should ultimately make the difference in the anticipated capital market environment in 2022.

All in all, in 2022, the continued return opportunities of equities stand out in relative comparison to the most important other asset classes such as bonds, cash and gold, so that the focus of the Ethna-DYNAMISCH remains firmly on equities in the new year. For the time being, other asset classes only have their place in the portfolio for diversification reasons, if at all, and will probably only be used with a low weighting for the rest of the year. However, it is also true that the positive equity market scenario has clearly lost some of its strength compared to the past year. We therefore consider the high flexibility of the Ethna-DYNAMISCH to be all the more important going forward, in order to be well equipped to deal with alternative scenarios.

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